Modelling the Long–run Real Effective Exchange Rate of the New Zealand Dollar

In this paper we use the behavioural and permanent equilibrium exchange rate approaches to produce long–run equilibrium exchange rates for the effective real exchange rates of the New Zealand dollar. We demonstrate that a well founded measure of the equilibrium value of the dollar may be recovered from a relatively small set of fundamental variables and that this can be used to produce an assessment of the dollar in terms of periods of misalignment.     

A History of the D–Mark's Real External Value

An equilibrium time path of the real effective exchange rate of Germany's currency in the post Bretton Woods period is calculated. For this purpose, a NATREX model for the long–run determination of this specific variable is developed. A cointegration analysis gives evidence in favour of the model and provides the equilibrium values. The theoretical and empirical results are used to analyse in detail movements in the real exchange rate of the D–Mark. Estimation results suggest, among other things, that the D–Mark has mostly been overvalued and that it often adjusted with some delay to changes in the fundamentals.     

Nonlinear Exchange Rate Adjustment and the Monetary Model

Although the empirical literature has delivered evidence in favor of nonlinearities in nominal and real exchange rate adjustment, the corresponding mechanisms with respect to the relationship between nominal exchange rates and fundamentals in general have rarely been put under any close scrutiny. This paper extends the work of other authors, who estimate exponential smooth transition autoregressive models to deviations of the exchange rate from monetary fundamentals. Using monthly data from 1976:01 to 2010:12 for the USA, UK, and Japan, this paper first adopts a cointegrated vector autoregression (VAR) framework to test for the multivariate validity of the monetary model by applying restrictions on the long‐run relationships. Then, nonlinear vector error correction models are estimated to tackle the question of whether the adjustment of the nominal exchange rate with respect to those relationships follows a nonlinear path.     

Accounting for Growth and Output Gaps: Evidence from New Zealand

We evaluate New Zealand's macroeconomic performance over the 1967–1996 period, which witnessed numerous economic reforms. Using both index–number and econometric techniques, we decompose nominal GDP growth and the output gap into contributions from price level changes, productivity growth and changes in factor utilisation. Changes in domestic prices accounted for four–fifths of the growth in nominal GDP, while capital accumulation and employment growth were the most important factors determining real–output growth. Deviations in the domestic price level around its long–run trend contributed most heavily to changes in the nominal output gap. The real gap was influenced in any year variously by deviations of the terms of trade and labour input from their long–run trends, as well as by productivity shocks.     

Viewpoint: Towards a solution to the puzzles in exchange rate economics: where do we stand?

Abstract.  This paper provides a selective overview of puzzles in exchange rate economics. We begin with the forward bias puzzle: high interest rate currencies appreciate when one might guess that investors would demand higher interest rates on currencies expected to fall in value. We then analyse the purchasing power parity puzzle: the real exchange rate displays no (strong) reversion to a stable long‐run equilibrium level. Finally, we cover the exchange rate disconnect puzzle: the lack of a link between the nominal exchange rate and economic fundamentals. For each puzzle, we critically review the literature and speculate on potential solutions. JEL classification: F31     

Dynamic Stability, Paradoxical Comparative Statics, and Factor–Market Distortions in an Economy with Three Production Sectors

In an earlier paper the authors clarified the relationship between the stability of long–run equilibrium and the possibility of paradoxical comparative statics in the Lerner–Samuelson two–by–two model of production with factor–market distortions (see Review of International Economics 9 (1901) :383–400). The present paper extends the analysis to an economy with three production sectors. It is found that almost all properties of long–run equilibrium in the two–by–two model with factor–market distortions continue to hold, while some new properties, such as plurality of equilibrium, appear. Specifically, the instability of the adjustment process is not ruled out; a paradox cannot coexist with stable equilibrium in a small open economy, but may do so in a closed economy.     

Productivity Shocks and Real Effective Exchange Rates

This paper provides new insights into the relationship between exchange rates and productivity developments for European Economies. We focus on the question whether productivity changes have a long‐run impact on real effective exchange rates for a large number of European economies. Focusing on a sample period running from 1995 until 2013, we adopt a cointegrated vector autoregressive approach and distinguish between long‐run equilibrium, short‐run dynamics and long‐run impact of shocks. Our findings show that for several industrialized economies, real effective exchange rates and labor productivity are not related over the long‐run. A possible explanation for this result is that wage developments do not reflect increases in labor productivity to a large degree, which prevents a transmission to the real effective exchange rate through the price channel. The results for Central and Eastern European Countries are more encouraging since a positive impact of labor productivity on real effective exchange rate is frequently observed.     

Does the Long–run PPP Hypothesis Hold for Africa? Evidence from a Panel Cointegration Study

The long–run purchasing power parity (PPP) concept is empirically studied using the parallel market exchange rates of 17 African countries and employing the panel cointegration method. This approach is particularly useful when analysing African countries, which do not have long time–series. This paper presents results that support the weak–form of the long–run PPP hypothesis in Africa, which does not require a homogeneity restriction on prices.     

The Behaviour of the Real Exchange Rate: Evidence from an Alternative Price Index

Although the long–run purchasing power parity (PPP) hypothesis is expected to hold across tradable goods, all price indices available to researchers for testing the validity of PPP contain some proportion of non–tradable goods prices, which may generate substantial persistence in the real exchange rate. We construct time series for quarterly price indices that minimize the presence of non–tradable goods for six major economies. Applying recently developed nonlinear econometric techniques to the resulting five US dollar real exchange rate series for the recent floating exchange rate regime, we provide evidence that the nonlinear mean reverting properties of these real exchange rate series are stronger than the mean reverting properties of real exchange rate time series constructed using the consumer price index (CPI). In turn, these results have a natural economic interpretation.
(J.E.L.: F31).     

Disorderly adjustments to the misalignments in the Korean won

This paper estimates the equilibrium exchange rates for Korea'sreal effective rates using Clark and MacDonald's (1999) behaviouralequilibrium exchange rate (BEER) approach. The estimation resultsuggests that the real exchange rate was substantially overvaluedduring the period prior to the currency crisis of 1997–98.The subsequent adjustment, however, was disorderly in the sensethat the real exchange rate overshot its long-run equilibriumvalue. There was also a large deviation from the BEER, indicatingthat the sharp depreciation was not an equilibrium phenomenon.     

Sources of Fluctuations in the Real Exchange Rates and Trade Balances of the G‐7: A Sign Restriction VAR Approach

This paper estimates structural vector autoregression models of output, the real exchange rate and trade balance for the group of seven leading advanced economies (G‐7). Unlike previous studies, we do not impose long‐run purchasing power parity as an identifying assumption; instead, the shocks underlying the model are structurally identified using a set of theory‐consistent sign restrictions. Empirical results show that nominal shocks account for most of the long‐run variability in trade balances across the G‐7 countries. We are able to attribute this finding to long‐run movements in the real exchange rate, as the real exchange rate is significantly affected by nominal shocks in the long run.     

Sectoral labor adjustment and monetary policy in a small open economy

This paper studies the welfare implications of sectoral labor adjustment cost in a two-sector small open economy model with sticky prices. We find that, when the economy faces external shocks, if monetary policy can stabilize the real economy, then sectoral labor market adjustment cost will lead to welfare loss. However, if monetary policy such as fixed exchange rates cannot stabilize real variables, then some degree of labor market friction will improve welfare instead and the gain will be significant. As a result, the welfare gap between flexible exchange rates and fixed exchange rates decreases with sectoral labor market friction. This is because the friction can offset some of the nominal rigidity and become a substitute for monetary policy to stabilize the real economy.     

Foreign exchange market interventions and the $–¥ exchange rate in the long run

This article examines whether foreign exchange market interventions conducted by the Bank of Japan are important for the dollar–yen exchange rate in the long run. We rely on a re-examination of the empirical performance of a monetary exchange rate model. This is basically not a new topic; however, we focus on two new questions. First, does the consideration of periods of massive interventions in the foreign exchange market uncover a potential long-run relationship between the exchange rate and its fundamentals? Second, do Forex interventions support the adjustment towards a long-run equilibrium value? Our results suggest that taking periods of interventions into account within a monetary model does improve the goodness of fit of an identified long-run relationship to a significant degree. Furthermore, Forex interventions increase the speed of adjustment towards long-run equilibrium in some periods, particularly in periods of coordinated forex interventions. Our results indicate that only coordinated interventions seem to stabilize the dollar–yen exchange rate in a long-run perspective.     

Fiscal Policy and Exchange Rates

This paper examines the dynamics of the nominal exchange rate and fiscal deficits in a continuous time optimizing general equilibrium model with OLG. It is shown that alternative financing modes of budget deficits imply different patterns of adjustment along the transitional path towards the steady-state equilibrium. In particular, the respect of public solvency without money financing is not sufficient to avoid the depreciation of the exchange rate in the long-run after a fiscal expansion. In addition, money and tax financing generate opposite intergenerational reallocation of wealth.     

THE HARROD–BALASSA–SAMUELSON HYPOTHESIS: REAL EXCHANGE RATES AND THEIR LONG‐RUN EQUILIBRIUM*

Frictions and perturbations may influence currency values in the short run, but it is generally acknowledged that real‐exchange rates eventually settle toward equilibrium. The puzzle then is how gradually this parity is reached given the fluidity in foreign exchange markets. Persistent differences in the relative productivity of countries—a broad characterization of the Harrod–Balassa–Samuelson hypothesis—may help explain this puzzle. This article introduces methods to estimate equilibrium adjustment paths semiparametrically, and then sort how each of these components influences the dynamics of exchange rates. This is done in a dynamic panel setting by introducing novel local projections methods for cointegrated systems. Productivity shocks affect dynamics, and after adjusting for these factors, adjustment toward equilibrium is relatively rapid.     

The nominal rate of interest, the rate of return on money, and inflationary expectations

This paper offers two modifications to the standard comparative-static analysis that help explain why nominal interest rates may either over- or under-adjust to a change in inflationary expectations, even in full general equilibrium: the inclusion of the real rate of return to money balances in commodity demand functions, and the presence of differing costs of obtaining information. In brief, the first factor may explain why nominal interest rates could over-adjust to a change in inflationary expectations, while the second may substitute for real balance effects in limiting the upward adjustment of nominal rates.     

Money, capital, and real liquidity effects with habit formation

Abstract.  The money in utility model is reconsidered in the presence of endogenous labour and habits. With standard assumptions about preferences and a policy rule that sets the nominal interest rate by adjusting the growth rate of money, the model exhibits superneutrality in the steady state. Nevertheless, habits give rise to real liquidity effects in the short run. After an increase in the nominal interest rate, employment falls, resulting in a fall in capital accumulation and in the short‐ and long‐term real interest rates. The adjustment of the capital stock is non‐monotonic. Employment and the short‐ and long‐term real interest rates may also adjust non‐monotonically. JEL classification: E22, E52, E58     

China’s equilibrium exchange rate dynamics 1994–2004: A cointegration analysis

Motivated by the global debate on the possible revaluation of the Chinese currency, the RMB, in recent years, the objective of this paper is to measure the equilibrium value of the RMB exchange rate through the macroeconomic balance approach in order to produce an assessment of the RMB in terms of periods of misalignment. The empirical evidence indicates that although there turns out to be an increasing degree of the RMB undervaluation in these measures from 2003 to 2004, the RMB is not substantially undervalued in both measures of real effective exchange rates and nominal bilateral exchange rates against the US dollar over the full period 1994–2004.     

Optimal Monetary Policy

Optimal monetary policy maximizes the welfare of a representative agent, given frictions in the economic environment. Constructing a model with two sets of frictions—costly price adjustment by imperfectly competitive firms and costly exchange of wealth for goods—we find optimal monetary policy is governed by two familiar principles. First, the average level of the nominal interest rate should be sufficiently low, as suggested by Milton Friedman, that there should be deflation on average. Yet, the Keynesian frictions imply that the optimal nominal interest rate is positive. Second, as various shocks occur to the real and monetary sectors, the price level should be largely stabilized, as suggested by Irving Fisher, albeit around a deflationary trend path. Since expected inflation is roughly constant through time, the nominal interest rate must therefore vary with the Fisherian determinants of the real interest rate. Although the monetary authority has substantial leverage over real activity in our model economy, it chooses real allocations that closely resemble those which would occur if prices were flexible. In our benchmark model, there is some tendency for the monetary authority to smooth nominal and real interest rates.     

The internal and external equilibrium exchange rate of RMB: 1982–2010

This paper estimates fundamental equilibrium exchange rate of RMB based on internal and external balance of China’s economy. The findings indicate that RMB real exchange rate is overvalued in the period of 1982–1991, but the extent of the undervaluation has an enlarging trend since 2004. Then, we put forward a new theory called “Prior Equilibrium Exchange Rate” and apply it to RMB, finding that real effective exchange rate of RMB need to be appreciated about 20% between 2008 and 2010, and the appreciation range of bilateral nominal exchange rate between RMB and the world’s key currencies depends on the objective functions of the government. Policy implication indicates that decision makers need to refer to equilibrium exchange rate which is derived from different theories and to make great efforts to adjust it towards equilibrium level and establish RMB “Prior Equilibrium Exchange Rate.” Meanwhile, policymakers should implement a potential objective interval system of exchange rate appreciation. The appreciation range of bilateral exchange rate of RMB against USD from 2008 to 2010 may be set between 6% to 10%.